Oil's Downhill Skid May Be Ending

For a nation mired in recession, it has a nice ring: The Oil Price Crash of '92. And for months now, that has been the talk around the oil markets as traders ponder brimming storage tanks, a worldwide economic slowdown, and unchecked OPEC production. Already, crude prices have nose-dived more than $5 a barrel from their October highs (chart), with some experts predicting that the slide is barely half over.

Don't bet on it anytime soon. In recent weeks, five normally contentious OPEC members have announced plans to cut production by a total of 300,000 barrels a day--with cartel kingpin Saudi Arabia joining in on Jan. 21. With OPEC pumping more than 24 million bbl. daily, the cutback is minor. Indeed, some experts see the moves as simple posturing aimed at heading off demands for deep cuts at OPEC's Feb. 12 meeting in Geneva. Still, "the fact that they are willing to cut at all is a significant step," says Michael C. Lynch, an analyst for consulting firm Washington International Energy Group. "It certainly improves the chances that for the second quarter, OPEC will be able to agree on oil-production cuts--and stabilize prices."

All eyes for months have been peering toward the gathering in Geneva. Nearly everyone expects a lively meeting, with Saudi Arabia as the central player. The country now pumps out 8.5 million bbl. a day--and alone has nearly picked up the slack in production caused by the near-total absence of Kuwait and Iraq from the oil markets. But with prices falling, other cartel members have grown antsy, pressing the kingdom to cut output to prop up prices. The Saudis have resisted, angering Iran and other price hawks by arguing that both demand and prices will rise as world economies rebound later in the year.

SAUDI DEFICIT. It's not an unreasonable view. But some experts, Lynch says, figure the Saudis have other motives. They think that in an American election year, the Saudis would like to help the U.S. out of its recession by keeping prices low. Economists say that with petroleum imports now running at a $50 billion annual clip, a sustained $4 drop in oil prices will put an extra $10 billion in the pockets of Americans over the next year. That could add about 0.3% to economic growth and, combined with potential tax cuts and lower interest rates, spark an upturn by summer.

But the latest move to cut production just a tad suggests that the Saudis aren't committed to helping prop up the U.S. economy indefinitely. The kingdom has run a budget deficit for the past several years--and a nearly $50 billion tab for the gulf war has further drained its coffers. That means, when push comes to shove, the Saudis are likely to find a way to hammer out an agreement with other OPEC members. "The Saudis don't have the financial freedom to maneuver that they once did," notes George F. Friesen, oil analyst for Deutsche Bank Capital Corp. in New York. "And that's why I think they won't let prices collapse to $15 a barrel."

LOWER DEMAND. If that succeeds in easing tensions in Geneva, it doesn't guarantee smooth sailing for oil producers. Friesen expects world oil demand to fall 2.4 million bbl. a day in the second quarter, to 65.6 million bbl. per day. Without further cuts, production will be at 66.2 million bbl., adding 600,000 bbl. a day to stocks that already are double normal seasonal levels. To drive prices back up, as some members want, OPEC will need to cut at least 1 million bbl. a day more, says Friesen. And that is still viewed as unlikely, since the cartel has always had trouble agreeing on dramatic action.

However any production cutback may be divided--and the Saudis likely would have to absorb much of it--oil experts figure OPEC will emerge from Geneva with a plan to stabilize oil prices near their current level of about $18.50 a bbl. Leo Drollas, chief economist at the Center for Global Energy Studies in London, a think tank led by former Saudi Oil Minister Ahmed Zaki Yamani, figures that prices will slowly erode over the second quarter, then firm in the third, thanks to normal seasonal demand.The real test for OPEC will come late in the year. Kuwait, now exporting around 350,000 bbl. a day, is expected to triple its output. When, as is widely expected, Iraq joins the fray this spring, the result could be 1.5 million bbl. a day in new supplies--at a time when, Drollas predicts, world demand will not have risen by much more than 600,000 bbl. "Somebody will have to accommodate those two countries," he says. "If it isn't the Saudis, it's difficult to see who will." For OPEC, that means the day of reckoning hasn't been avoided--just postponed.

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